Saturday, July 14, 2007

Correction over - going defensive

The S&P 500 has closed at an all-time high of 1552, ending a strange little correction that began in early June. My indicators tell me that the market is vulnerable to a correction now, so I've changed my market stance to "defensive."

Back-testing returns

Leveraged 2x funds have been available for about a year now (June 2006), so it's time to back-test my current method to see how well it's worked. The market was at the bottom of a correction in June '06, a time to buy 2x leveraged funds. The S&P and investor sentiment both returned to their trend lines in November, which was a signal to change back to defensive funds.

The next correction began in February of this year, as indicated by the dip below the November price of ~1400. That was the second signal to buy 2x funds. By May the market had returned to its upper trend line, signaling a return to defensive funds.

The most recent correction followed quickly in June, dipping below the May price level of 1505 and returning (intra day) to the market's upper trend line on July 13.

The following table shows the returns using the most conservative 2x fund, SSO:

DateBuySellCumulative
Return
Buy and
hold S&P
June 16 '06SSO-0%0%
October 26 '06SHYSSO20%10%
March 2 '07SSO
SHY22%10%
April 25 '07CSD+DBVSSO40%19%
June 7, '07SSOCSD+DBV45%19%
July 13CSD+DBVSSO56%24%

8 comments:

jademonki said...

I'm digging your blog / site here and learning quite a bit.

Saw your profile(s) on CAPS and I'm beyond impressed. Most there are playing the game CAPS and not so much real-life investing.

Do you think today's market action and the fed's comments will cause the markets to correct much ? also what ETF, in any would you recommend today in light of all this ?

thanks again,

jademonki

Hodarius said...

Hello jademonki,

Thanks for your comment and welcome to the blog!

Since the S&P 500 is near its upper trend line again (the ceiling is about 1560 now), the door is open to future corrections. However with all of the pessimism out there, I think any correction will be limited by put options being exercised and the record short interest. (Much of the sell-off has already happened!)

I don't worry too much about day-to-day news items affecting the market. I simply keep track of where people's monetary bets are and then bet against the majority. If statements by the Fed cause people to shift their bets, then I will adjust accordingly.

Right now most of my money is in CSD (an ETF of 40 spin-off companies) and DBV, which hedges 6 currencies against one-another. The latter fund is unaffected by stock market drops, so I'm 50% correction-proof right now.

jademonki said...

I really like the idea of a currency fund (dbv)and your strategy. I purchased some yesterday for a defensive play.
thanks for opening my eyes to this !

I've been reading up on ETF's since finding your blog here and it seems like an ETF can have all the advantages of an individual stock while limiting some of the risk due to it's own diversification. Do you agree ?

I have to say I've been having a hard time with the stock market lately and it seems all my picks are 180 degrees off. I'm trying to find a more fundamental approach to improve my bottom line. It seems like you believe in playing the broader market more than individual securities. Do you believe this is a much simpler/effective approach than trying to analyze or speculate about an individual security ?

thanks again for your input.

jademonki.

Hodarius said...

You hit the nail on the head - twice!

1) The diversification of an ETF makes it less risky than an individual stock. Sure, it also means that gains are smaller, but if you get in and out of the market at the right times (easy to do with ETFs), then moderate gains with minimal losses translates to big gains in the long run.

2) There are about 9000 stocks to chose from in the U.S. alone, and I personally don't have time to analyze cash flows, competition, management effectiveness, and growth forecasts for thousands of companies every single quarter.

Putting it all together, an investment in SPY or SSO (S&P 500) or IYY (total market) is an investment in America Inc. Forecasting that stock price is significantly easier than for an individual company.

And for investors who insist on concentrating on a subset of the market, there are smaller ETFs that let investors split the market up into as many or as few pieces as they want to: small/mid/large, growth/value/core/blend, about a dozen sectors, and so on.

jademonki said...

"personally don't have time to analyze cash flows, competition, management effectiveness, and growth forecasts for thousands of companies every single quarter."

well said... I don't have that kind of time myself. I probably spend 20 hours a week studying charts and technicals. This hasn't bode well with my portfolio and or my new marriage.

I started in stocks about 1997 and by 2000 had done well daytrading (like everyone did). Now that type of mind-set and my technical tools seem worthless. I have a bad habit of pulling the trigger without knowing anything about a company. It's a dangerous game I've been playing and I'm struggling to change all this.

So I'm looking for a simpler, more effective approach and this feels right so far.

Also I've noticed a lot of successful caps players will analyze a sector of the market and then pick the leaders or laggards depending on what they are looking for. Do you do this as well ?

thanks again for your blog here, it's my first stop every morning to reinforce what I've learned so far. Also I appreciate you taking the time to chat with me.

sincerely,

jademonki

Hodarius said...

Thanks for the kind complements, jademonki. I appreciate the feedback.

I stopped investing in individual stocks about a year ago. As far as whole sectors are concerned, I've only started looking at sector ETFs in the last couple of weeks.

I'm in the process of going through some historical data to look for any sector trends that could improve my returns. It may not yield anything, or it may simply be more trouble that it's worth. We'll see.

jademonki said...

So you stated your "going defensive" a few days back and as of today that seems amazingly accurate.

My question is ; do you rely mainly on technicals (trendlines, support, resistance) and the SP-500 to come up with these conclusions ? Or are you basing the corrections / bottoms of the market using many different tools ?

learning to fish...

jademonki

Hodarius said...

Well, I'm not as accurate as you might think from the last few days of market activity. The only bet I really made on Friday is that the market would no longer climb quickly. That means getting out of 2x funds.

For all I know, the S&P 500 could continue to climb along its trend line to 1600 by September, or it could plummet 5% tomorrow following some unforeseen event. Either way I win, because the combination of the currency fund (DBV) and spin-off fund (CSD) should do at least as well as the S&P 500 between now and the bottom of the next correction.